If you have an outsourcing contract, the chances are
that at some stage you will need to consider some form of
renegotiation. Up to three-quarters of all outsourcing deals are
renegotiated at some point, and this figure is rising.
This year, with a record number of contracts due to expire, the
profile and importance of renegotiation is set to rise. So what is
renegotiation, what is driving its importance, and how can you take
advantage?
Renegotiation is a dialogue aimed at agreeing major change with
your existing outsourcing supplier. It represents the first step in
trying to redefine an outsourcing contract.
Critically, renegotiation stops short of the “nuclear option” of
going back to the market to retender your requirements. Given the
massive cost and disruption that retendering and contract exit can
entail (not only finding a new supplier, but simultaneously
managing the exit of the old), renegotiation is usually the smarter
way to fundamentally redefine a contract.
Four basic triggers underlie almost all renegotiation. First,
and most obviously, is the timing factor. If contract expiry is
imminent, the outsourcing client needs to either agree an extension
with the current supplier, find a new supplier, or bring the work
back in-house.
Second, there is the issue of under-performance. This is not
always about pricing, although a recent Gartner survey showed that
40% of companies thought they were paying too much for outsourced
capabilities.
Underperformance also covers persistent shortcomings in service,
failure to meet key performance indicators over an extended period,
and underperformance against the market.
Underperformance may or may not entitle the client to legal or
financial recompense, but it undoubtedly provides a reason to
renegotiate.
A third and related type of trigger is contract flaws, which
often can only be resolved through renegotiation to address
omissions in the original contract or unintended behaviours from
poor drafting.
An example of this kind of trigger is the contract between EDS
and the US Navy Marine Corps, which went through extensive
renegotiations in 2004 to restructure and simplify the service
level regime.
Finally, major business change is an important driver of
renegotiation. Any good outsourcing relationship should be able to
deal with day-to-day change, in terms of minor scope extensions or
adjustments to service levels or pricing.
But when a proposed change could fundamentally alter the nature
of the relationship, contract renegotiation can be essential. For
example, when the client acquires a new business, moves into a new
market or hires a new CEO, the basic assumptions of the existing
deal may no longer apply.
This last trigger has resulted in a number of high-profile
renegotiations, such as the JPMorgan Chase deal with IBM ITO where
work was brought back in-house, and the Powergen deal with Vertex,
which resulted in litigation.
This trigger can also encompass the need to apply technology or
legislation not foreseen in the original deal, such as new
compliance requirements (who pays for Sarbanes-Oxley or Mifid
work?) or technology solutions.
Given these drivers, renegotiation is a complex challenge.
Ideally, client and supplier will have a frank and constructive
relationship, far removed from the brinkmanship and posturing that
characterises so much of outsourcing deal-making.
Successful outsourcing relies on building sustainable
relationships, not screwing out every last concession, and smart
negotiators will seek to ensure the relationship is underpinned by
clear mutual benefit on both sides.
Ultimately, however, the outcome of renegotiation will depend on
the negotiating position of both parties, which will be largely
determined by the options available to the client.
If, for example, the client could easily retender the work to a
range of other suppliers, a failure to agree would still leave
viable alternatives, which is a good basis for influencing the
renegotiation outcome.
In cases where one or both of the parties have attractive
alternatives, renegotiation is unlikely to get off the ground. In
all other cases, the parties will need to spend time negotiating
the point at which their interests and position intersect.
Improving your renegotiating power by developing alternative
sourcing options is a long-term task that should start before the
original contract is signed and continue throughout the deal. The
following broad concepts are the most important considerations:
l Build competition and transparency into the contract: minimise
your reliance on proprietary systems and software, and make use of
industry-standard processes, tools and benchmarking. Wherever
possible, try to promote a multi-sourcing approach by not relying
entirely on a single IT provider to supply all your needs for a
given function.
l Minimise the contractual barriers to exit: ensure that the
master contract provides a clear and equitable basis for
termination, both for “cause” and “convenience”. This should
include providing a fair mechanism for compensating the supplier
for the client’s premature exit. Clarify the responsibilities in
terms of transfer or retention of intellectual property and
personnel.
l Retain expertise: do not lose the ability to understand the
functional and technical detail of the deal. Run a contract
management office that retains a complete grasp of the outsourced
activities.
In addition to building up your sourcing options over the long
term, the actual process of renegotiation needs to be well managed.
The first consideration is getting the timing right.
Considering that a renegotiation process can last from two to
six months depending on the complexity of the situation, and that
12 to 18 months’ contingency is needed to run a retendering
process, starting a renegotiation fewer than 18 to 24 months before
the contract expiry date seriously reduces a client’s negotiating
leverage.
The starting point for the renegotiation process is establishing
a clear set of goals, and identifying those of the supplier – in
some situations, it will be possible to agree a joint statement of
shared objectives.
The objectives will provide an agenda for the renegotiation, and
should focus only on the killer issues, underpinned by a clear
picture of the longer-term requirements of the business, such as
the IT, finance and HR services it will need in the next two, five
and 10 years, and what its overall sourcing strategy is.
Finally, before starting to renegotiate, the client needs to
plan the terms of engagement with the supplier, clearly setting out
fair rules, such as the number of people who will be involved, and
the timeline for concluding (or calling off) the renegotiation.
A clear and disciplined approach for the renegotiation sessions
themselves is essential. Central is the use of a single, jointly
edited version of the contract, capturing revisions to the
agreement in real time.
Progress will rely heavily on the quality of the underlying
relationship between client and supplier, as mistrust or tactical
games will delay or derail agreement.
Senior client and supplier involvement is also vital,
symbolically emphasising mutual commitment to the process, while
minimising decision-making delays.
Renegotiation is not a panacea. Redrafting a contract is no
substitute for maintaining a constructive relationship with your
supplier. Where problems persist, termination and retendering may
well be the right answer.
But although retendering continues to get all the headlines,
dozens of forward-looking firms are turning to renegotiation to
refine and extend their sourcing strategies.
As deals get shorter, and as firms get better informed and more
sophisticated in their outsourcing thinking, a silent revolution
will take place in attitudes.
Renegotiation will no longer be a niche activity; it will emerge
as a central skill for all businesses engaged in outsourcing.
l Paul Morrison is a senior manager at outsourcing advisory firm
Alsbridge
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